Owner who made 401(k) Deferrals with zero Earned Income

[Alex Daisy]

I am working on a ADP test and I have two owners of a company who deferred $16,500 each and now they are reporting to me what their K-1 will show zero earned income.

What are the conseqeunces of this and what has to be done?

Do I include the owners in the ADP test?

[Tom Poje]

the preamble to the final regs says:

One commentator asked for clarification of the interaction between these timing

rules and the rule under the regulations that treats a self-employed individual’s earned income as being currently available on the last day of the individual’s taxable year and whether this last day rule precludes a partner from making elective contributions during the year through a reduction in the partner’s draw. The restriction on the timing of contributions is not intended to prevent a partner from deferring amounts that are paid to the partner throughout the year on account of services performed by the partner during the year, and the final regulations have been modified to clarify this point. However, self-employed

individuals who take advantage of this opportunity to defer amounts during the year must make sure that the amount contributed during the year will not exceed the limits (such as the limits of section 415) that will apply to the individual, based on the individual’s actual earned income for the relevant period.

therefore, it sounds like you have a 415 limit violation and should correct under those guidelines.

the answer as to whether to include the HCEs in testing as 0% is left up to debate. at prior conferences, the IRS officials have said to exclude them entirely, but there is nothing written in stone on the issue.

[Alex Daisy]

the preamble to the final regs says:

One commentator asked for clarification of the interaction between these timing

rules and the rule under the regulations that treats a self-employed individual’s earned income as being currently available on the last day of the individual’s taxable year and whether this last day rule precludes a partner from making elective contributions during the year through a reduction in the partner’s draw. The restriction on the timing of contributions is not intended to prevent a partner from deferring amounts that are paid to the partner throughout the year on account of services performed by the partner during the year, and the final regulations have been modified to clarify this point. However, self-employed

individuals who take advantage of this opportunity to defer amounts during the year must make sure that the amount contributed during the year will not exceed the limits (such as the limits of section 415) that will apply to the individual, based on the individual’s actual earned income for the relevant period.

therefore, it sounds like you have a 415 limit violation and should correct under those guidelines.

the answer as to whether to include the HCEs in testing as 0% is left up to debate. at prior conferences, the IRS officials have said to exclude them entirely, but there is nothing written in stone on the issue.

How do I distribute the $16,500 from the Plan, as a refund, or is it left in the Plan as forfeiture?